What is a trend line in forex trading?
A trend in trading is defined as the general direction in which a financial market’s value or an asset’s price moves. In technical analysis, trends are identified by trend lines.
Lately, trend lines have become widely popular as a form of technical analysis in order to identify support or resistance levels.
A trend line is an easily recognisable straight line that connects a series of price points and then extends into the future to represent either support or resistance, depending on the direction of the trend.
In forex trading, support refers to a situation when declining prices stop, change direction, and begin to increase. Resistance is a price level where rising prices halt, change direction, and begin to decrease.
Support is often observed as a ‘floor’ which is supporting (holding up) declining prices, while resistance is viewed as a ‘ceiling’ which is preventing prices to continue in an upward trend.
Usually, in technical analysis, support and resistance are horisontal levels or areas on trading charts, indicating potential buying or selling pressure. It is the same for trend lines, with the difference that trend lines are not horisontal but sloping in an upward or downward direction.
Trend lines are important, both for trend identification and confirmation.
However, it is not always possible to draw trend lines on every price chart. Therefore, it is beneficial not to force the issue when the low points or the high points do not match up. Eventually, the best trend lines are the obvious ones.
Types of trend lines
Generally, there are two types of trend lines, namely an upward trend line and a downward trend line.
Upward trend line
An upward trend line, also known as an uptrend line or an ascending trend line, is basically drawn along the bottom of support areas (alleys) that are easily recognisable.
An ascending trend line has a positive slope and is created by connecting the low points. To form a positive slope, the second low point must be higher than the first low and to be judged a valid trend line, at least three low points must be connected.
Uptrend lines function as support and indicate that the demand for a currency is greater than the supply, implying that the price is likely to continue its upward trend.
An upward trend line is a signal of upward buying pressure and an increasing price combined with rising demand indicates a bullish market.
While prices stay above the trend line, the upward trend is considered solid and unflawed. However, a break below the uptrend line is an indication that net-demand (demand less supply) has decreased and a trend change could be forthcoming.
Downward trend line
A downward trend line, also referred to as a descending trend line or a downtrend line, is drawn along the top of easily recognisable resistance areas, also called peaks.
A downtrend line constitutes a negative slope and is formed by connecting the high price points. To form a negative slope, the second high point must be lower than the first low, and to be considered a valid trend line, at least three points must be connected.
Descending trend lines perform as resistance and signal that the net-supply (supply less demand) for a currency is rising even as the price falls.
A falling price in combination with an increasing supply is distinctly bearish, signaling downward selling pressure.
As long as currency prices stay below the downward trend line, the downtrend is considered solid and unflawed. However, a break above the downtrend line is an indication that net-supply is dwindling, and a trend change could be on the way.
How to draw trend lines
As mentioned earlier, trend lines in forex trading are simply lines that connect a series of price points to enable a trader to better predict the imminent direction of a currency’s price.
Furthermore, always keep the general rule in technical analysis in mind – it takes two points to draw a trend line and a third point to confirm its validity. The more price points included in the trend line, the more credibility attached to the support or resistance level illustrated by the trend line.
Moreover, as with horisontal support and resistance levels, trend lines gain strength the more times they are tested.
And some words of caution.
- The more vertical the trend line you draw, the less reliable it is going to be and the more likely it will break off.
- Be cautious not to be overly subjective when looking for trend lines. Therefore, it is important to decide on your method to draw them and then be consistent.
In conclusion, take note of the following salient points when drawing your own trend lines.
Utilizing higher time frames
With most price action methods, higher time frame trading charts proved to respond better when drawing trend lines. Thus, the higher time frames will always form the most reliable trend lines.
In this regard, it is beneficial and meaningful to start with a daily time frame because it represents an extended time period. This strategy is also based on an important principle concerning trend lines: The longer a trend line is valued, the more important it becomes.
A daily time frame enables a trader to better identify the long-term trend, presenting meaningful price movements. Contrarily, lower time frames, such as an hour or two, produce a lot of irregular price movements.
Trend lines and overlap
In forex trading, candlestick charts display the high, low, open, and closing prices of a currency for a specific period. With regard to drawing trend lines, one of the most common questions is, should they be drawn from the open/close of a candlestick or from the high/low?
You seldom will find a trend line that lines up completely with high points or low points. Similarly, it is uncommon to find a trend line that is perfectly in line with the opening and closing prices of each candlestick. Most trend lines will have some overlap from the low or high of a candlestick.
Therefore, the crucial part of any trend line is to draw the line to touch the high price points (or low price points) without cutting off part of a candlestick.
NEVER try to force a trend line to fit
Do not ever draw trend lines by forcing them to fit, even if you are unquestionably convinced that a support or resistance level exists. If it does not fit the chart, then it is not valid. Be careful not to fall in the trap of ‘curve fitting.’
Frequently Asked Questions
What is a trend line in forex?
Read our helpful guide – Trend lines in Forex Trading Explained for Dummies
When is a trend line in forex valid?
You will know that the trend line in forex is valid when there at least three highs or lows used.
Why do we use trend lines?
To indicate to traders the direction in which an investment’s value might move.
What does a very steep trend line in forex indicate?
A very steep trend line isn’t reliable and will most probably break.
Should you draw trend lines by forcing them to fit the market?
No absolutely not, Do NOT ever DO that.
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